4. (20 points) You are considering two types of batteries. Type A costs $20 per battery and lasts for 2,500 hours. Type B lasts for 5,000 hours. Suppose that you are planning to use one of these batteries for your long-term project. This project implies operating those batteries 250 days per year, 10 hours per day. Annual required rate of return is 10%. Ignore depreciation considerations. Suppose that you need to start operating one of the batteries tomorrow. (a) (7 points) What should the price of battery B be to make it more attractive to you? (b) (7 points) Suppose that your project will only last for 10 years, after which you are planning to stop your business and retire. How does answer your answer change? Briefly explain your result. (c) (6 points) Suppose now that you plan to double daily working hours. Suppose that you have chosen to go with battery A. What is net present cost of buying these batteries over the life-time of the project (suppose again that the project is long-term)? 5. (15 points) Your corporation is thinking to automate its production. The automation system is going to cost $500,000. It will be used in a 5-year project, but its depreciation schedule is over three years. In particular, depreciation allowance is 50% in year 1, 30% in year 2 and 20% in year 3. You expect the market value to be $20.000 at the end of year 5. The required initial increase in working capital (in year 1) is $40,000. Suppose that tax rate is 20%, and the required cost of capital is 15%. (a) (8 points) Suppose that the automation project is going to increase sales by $5,000 per year and also reduce costs. What level of annual pretax cost savings should the automation project generate in order to be financially attractive? (b) (7 points) What if depreciation schedule is linear (that is, every year depreciation amount is $100,000)? Briefly comment why pretax cost saving is higher or lower than in part (a). 4. (20 points) You are considering two types of batteries. Type A costs $20 per battery and lasts for 2,500 hours. Type B lasts for 5,000 hours. Suppose that you are planning to use one of these batteries for your long-term project. This project implies operating those batteries 250 days per year, 10 hours per day. Annual required rate of return is 10%. Ignore depreciation considerations. Suppose that you need to start operating one of the batteries tomorrow. (a) (7 points) What should the price of battery B be to make it more attractive to you? (b) (7 points) Suppose that your project will only last for 10 years, after which you are planning to stop your business and retire. How does answer your answer change? Briefly explain your result. (c) (6 points) Suppose now that you plan to double daily working hours. Suppose that you have chosen to go with battery A. What is net present cost of buying these batteries over the life-time of the project (suppose again that the project is long-term)? 5. (15 points) Your corporation is thinking to automate its production. The automation system is going to cost $500,000. It will be used in a 5-year project, but its depreciation schedule is over three years. In particular, depreciation allowance is 50% in year 1, 30% in year 2 and 20% in year 3. You expect the market value to be $20.000 at the end of year 5. The required initial increase in working capital (in year 1) is $40,000. Suppose that tax rate is 20%, and the required cost of capital is 15%. (a) (8 points) Suppose that the automation project is going to increase sales by $5,000 per year and also reduce costs. What level of annual pretax cost savings should the automation project generate in order to be financially attractive? (b) (7 points) What if depreciation schedule is linear (that is, every year depreciation amount is $100,000)? Briefly comment why pretax cost saving is higher or lower than in part (a)
